Bernanke says the Fed can do more but…

I want to highlight the end of Fed Chairman Ben Bernanke’s speech at Jackson Hole yesterday because he reiterated something he has been saying for a while now – that the Fed will do more but it won’t be able to save the day by itself. I have underlined the important bits:

Early in my tenure as a member of the Board of Governors, I gave a speech that considered options for monetary policy when the short-term policy interest rate is close to its effective lower bound. I was reacting to common assertions at the time that monetary policymakers would be “out of ammunition” as the federal funds rate came closer to zero. I argued that, to the contrary, policy could still be effective near the lower bound. Now, with several years of experience with nontraditional policies both in the United States and in other advanced economies, we know more about how such policies work. It seems clear, based on this experience, that such policies can be effective, and that, in their absence, the 2007-09 recession would have been deeper and the current recovery would have been slower than has actually occurred.

As I have discussed today, it is also true that nontraditional policies are relatively more difficult to apply, at least given the present state of our knowledge. Estimates of the effects of nontraditional policies on economic activity and inflation are uncertain, and the use of nontraditional policies involves costs beyond those generally associated with more-standard policies. Consequently, the bar for the use of nontraditional policies is higher than for traditional policies. In addition, in the present context, nontraditional policies share the limitations of monetary policy more generally: Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces. It certainly cannot fine-tune economic outcomes.

As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation. The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.

Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

Isn’t this exactly what I have said Bernanke was saying all along:

Ben Bernanke, has repeatedly said he believes inflationary pressures are subdued. So he believes more needs to be done to promote full employment. I agree.

But what can the Fed do? Usually the Fed lowers interest rates to stimulate the economy. But, the Fed has said the federal funds rate will be effectively 0 percent through late 2014. So the Fed has resorted to less proven, less effective means like buying up Treasury bonds or informing bond markets that it intends to keep the federal funds rate at 0 percent for longer. This won’t cut it.

So Bernanke has told Congress the Fed cannot do it alone, without interfering in fiscal policy by making specific recommendations. Congress needs to do more to bring down the unemployment rate, the broadest measure of which is 15.3 percent. 

Why aren’t people listening?

Let me put it in easy to read language. Here’s a bullet-point version of what the Fed Chairman is saying:

• We would be lowering rates if we could but rates are zero percent.
• So what? Just because rates are zero, we don’t think that means the Fed is impotent. There’s a lot we can do and will do if necessary.
• But these extra things we can do – like buying Treasuries, mortgage securities or even municipal bonds or fixing interest rates we normally don’t control – don’t work in getting us back to full employment as well as lowering rates, so things have to be pretty bad before we fire up the helicopters.
• That said, things would work MUCH better if Congress got into the act because we don’t buy this structural unemployment crap. People are out of work because of a shortage of demand – and government is making it worse.

Do I agree with this assessment? Mostly, but I do think QE has very negative long-term side effects in terms of capital allocation and private portfolio preferences that are now all around us. William White recently pointed this out. Still, Bernanke is in a damned if you do, damned if you don’t situation. Whatever he does or doesn’t do, the Fed will be pilloried by leading economists who are at once very divided on what the Fed should do and very vocal about their opinions.

Source: Federal Reserve Board